Introduction to Percentage-Based Rebalancing

Percentage-based rebalancing is a strategy employed by investors to maintain their desired asset allocation over time. As the value of different investments fluctuates, the actual percentage of each asset class in a portfolio can drift from the target allocation. By rebalancing, investors can buy low and sell high, aligning their portfolios with their risk tolerance and investment goals. Here are three diverse, practical examples of this technique.

Example 1: Retirement Portfolio Rebalancing

In a retirement portfolio, an investor has chosen a target allocation of 60% stocks and 40% bonds. Over time, due to market fluctuations, the stock portion grows to 70%, and the bond allocation drops to 30%. To bring the portfolio back to its target allocation, the investor decides to sell some stocks and buy bonds.

1. Initial Investments: $60,000 in stocks, $40,000 in bonds (Total: $100,000)
2. Current Value: $70,000 in stocks, $30,000 in bonds (Total: $100,000)
3. Target Allocation: 60% stocks ($60,000) and 40% bonds ($40,000)
4. Rebalancing Action: Sell $10,000 worth of stocks to buy bonds.
5. New Portfolio: $60,000 in stocks and $40,000 in bonds.

Notes: This example highlights the importance of periodically assessing your portfolio, especially as retirement approaches. Variations can include adjusting the target allocation based on changing risk tolerance or market conditions.

Example 2: Young Investor’s Growth Portfolio

A young investor prioritizes growth and has a target allocation of 80% stocks and 20% bonds. After a strong market run, stocks now make up 90% of the portfolio, while bonds have decreased to 10%. The investor decides to rebalance to maintain their risk profile.

1. Initial Investments: $80,000 in stocks, $20,000 in bonds (Total: $100,000)
2. Current Value: $90,000 in stocks, $10,000 in bonds (Total: $100,000)
3. Target Allocation: 80% stocks ($80,000) and 20% bonds ($20,000)
4. Rebalancing Action: Sell $10,000 worth of stocks to buy bonds.
5. New Portfolio: $80,000 in stocks and $20,000 in bonds.

Notes: Young investors often have a higher risk tolerance. However, they should still practice rebalancing to prevent overexposure to market volatility. Variations might involve smaller, more frequent rebalancing to adjust to rapid market changes.

Example 3: Balanced Fund Rebalancing

Consider a balanced fund that aims for a 50/50 split between equities and fixed income. Due to a market downturn, equities drop to 40% of the portfolio, while fixed income rises to 60%. The fund manager decides to rebalance to adhere to the fund’s strategy.

1. Initial Investments: $50,000 in equities, $50,000 in fixed income (Total: $100,000)
2. Current Value: $40,000 in equities, $60,000 in fixed income (Total: $100,000)
3. Target Allocation: 50% equities ($50,000) and 50% fixed income ($50,000)
4. Rebalancing Action: Purchase $10,000 worth of equities by selling fixed income assets.
5. New Portfolio: $50,000 in equities and $50,000 in fixed income.

Notes: This example illustrates how funds manage risk and ensure alignment with investment objectives. Managers may choose to rebalance quarterly or semi-annually based on specific policies or market conditions.